JP’s Journal: No way out

The UK election campaign has got off to a predictable start. The Conservative Party has offered further advantages to pensioners, accused the Labour Party of a plan to increase VAT and outlined a new National Service commitment.

The Labour Party has been caught up in internal squabbles about candidate selection and has matched most tax commitments from the Conservatives – including no change in VAT. So far in the campaigns, there appears to be little willingness from any major political party to discuss key issues.

The ‘conspiracy of silence’ over the state of the UK’s public finances, called out by the Institute of Fiscal Studies (IFS) earlier in the year, is an apt phrase. In simple terms, the public want better services and more government interventions to bring about higher levels of prosperity. The best way to achieve this is through higher real economic activity and this will depend on reversing the downward trend in productivity growth. Even if this were in the gift of government – and the poor productivity record in the public sector indicates a lot of room for improvement – it will take time. This is way outside the much shorter timescale of the fiscal rules – to get debt as a percentage of GDP on a downward path on five years horizon (a moving target). Both major parties are tying themselves in knots and something will have to give unless there is an immediate productivity miracle. This will mean spending cuts, higher borrowing, or tax increases. There is little prospect of spending cuts from a Labour government given the stringent approach already baked into plans for non-protected spending areas and commitments already made on the NHS and welfare. Liz Truss’s spectacular own goal and her failure to convince on ‘growth through unfunded tax cuts and higher government borrowing’ has shown the constraints now imposed by the gilt market. Interestingly, the public are more savvy. A poll last week showed that more than 50% believe that taxes will rises – under either Labour or the Conservatives. It is undoubtedly naïve to think that parties seeking election will be upfront on unpalatable truths but it limits debate.

This is not the only missing issue. The most consequential decision taken in the UK in the last 50 years is not up for discussion. The decision to leave the EU and on what terms (the latter not mandated in the referendum but determined subsequently) seem to be taboo subjects. This is a failure of leadership but reflects the fragile coalitions that make up both major parties. In economic terms it means that our trading relationship with the EU will continue as is, and will probably only be revisited after a further general election. Unless we find trade agreements to compensate, the present situation will continue to be a drag on growth. As Prime Minster Johnson found out, regaining sovereignty and making use of it are two different things.

The war in Ukraine rumbles on without any meaningful debate on the consequences of a victory for Russia and the impact on European security. In the coming years we are likely to see more encroachment on what were previously thought to be established national boundaries. With the news that the British army is now back to the size it was before the Napoleonic Wars, when the population was about a tenth of the current size, it seems inevitable that defence spending will increase. Geopolitics will also impinge on energy security and net zero policies; there seems little enthusiasm to address this either.

Government bond yields drifted higher over the week with 10-year US treasuries closing at 4.5%. In the UK, 10-year gilt rates touched 4.4% before rallying on US data which indicated a marginal improvement in core inflation. Similarly, euro area yields nudged higher although the expectation of an imminent rate cut remains intact. For choice, credit spreads widened but there was no particular theme. There remains strong demand for investment grade bonds that offer a meaningful yield premium over government debt.

The changing nature of financial markets was illustrated with the news that Nvidia, a company whose market capitalisation was around $10bn 10 years ago, now has a value ($2.7 trn) greater that the largest one hundred companies quoted in the UK. Looking at this in relation to bond markets, Apple, Microsoft and Nvidia have a combined value approaching $9 trillion, about three times the size of the combined conventional and index gilt market.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.